Following the birth of my daughter, my spouse and I began looking at college tuition rates and anxiously saying to one another, “if college is expensive now, imagine how expensive it will be in 18 years.” This “sticker shock” led me to research, and eventually open, one of the most commonly used educational savings accounts for the benefit of our daughter, a 529 plan.
However, selecting a plan was more complicated and nuanced than we originally envisioned.
The United States Securities and Exchange Commission defines a 529 plan as, “a tax-advantaged savings plan designed to encourage saving for future education costs ... (that) are sponsored by states, state agencies or educational institutions and are authorized by Section 529 of the Internal Revenue Code.”
Essentially, there are two types of 529 plans available to forward-looking parents: prepaid tuition plans and education savings plans. Prepaid plans allow the account holder to buy credits at participating colleges and universities for future tuition at current prices for the benefit of another. Better said, an account holder is able to lock into a participating college or university’s current tuition rate to pay for future college credits which will presumably be more expensive in the future.
The typical prepaid tuition plan, however, cannot be used to pay for room and board. This type of plan does not permit the account holder to prepay for elementary, middle or high school tuition either.
It is also important to note that, only a handful of states, offer prepaid tuition plans and only some plans allow the funds to be used towards out of state tuition. For instance, Ohio does not offer a prepaid tuition plan, therefore, this type of plan was not an investment option for me. My daughter’s grandparents, however, live in a state in which prepaid plans are both available and may be used at a college or university in their state or at an out-of-state school, and for that reason, they have opened a prepaid tuition plan for the benefit of my daughter.
Given the restrictions associated with pre-paid tuition plans, the education savings plan is the more commonly utilized of the 529 plans. Education savings plans, also known as the college savings plan, allow an account holder to place after-tax contributions in an investment account that can be withdrawn in the future for a beneficiary’s educational expenses including tuition, room and board. Money held in an education savings plan can be used for elementary and secondary school tuition along with college and graduate school expenses. The earnings that come from investing in a 529 plan cannot be taxed so long as funds withdrawn from the plan are used to cover qualified expenses (i.e. tuition, books, computers, room and board, etc.).
In addition, Ohio offers a tax deduction for account holder contributions to a 529 plan up to $4,000 per year. However, this is not to say that an account holder is unable to contribute more than $4,000 to a 529 plan per year. If an Ohioan tax payer and account holder contributes more than $4,000 in a particular year, the tax payer can deduct the overage the following year. The aforesaid tax benefits combined with the versatility of the plan, caused me to open an education savings plan for the benefit of our daughter.
While my spouse and I are comfortable with our 529 plan choices, our choice may not be right for you and your family. Prior to investing or purchasing any 529 plans, it is important to read the terms, conditions and prospectus of potential plans to make sure that you understand the nuances that may exist. Further, it is important to remember, that while researching 529 plans may be arduous at times, it’s always better to start saving early because your child will be 18 years old before you know it.
Andrew Zashin writes about law for the Cleveland Jewish News. He is a co-managing partner with Zashin & Rich, with offices in Cleveland and Columbus.